Contestable markets

• Contestable market:

  Market structure in which no one firm can dominate enough to make supernormal profits due to the THREAT OF COMPETITION.
• Characteristics of a contestable market

  1. low barriers to entry or exit​
  2. No sunk costs​
  3. All firms in the market can access new technology​
  4. Good information leading to little consumer loyalty​
  5. Incumbent firms are subject to 'hit and run' competition
  6. Firms may produce homogeneous or differentiated goods
  7. Short-run profit maximisers
  8. Threat of competition keeps profits low in long run
• Productive efficiency in a contestable market:

  A firm can feel threatend by a firm entering the market and operating at the lowest average cost of production, even if only normal profits are made.

  As such to avoid new entrants they will operate towards the bottom of the AC curve increasing productive efficiency.
• Allocative efficiency in a contestable market

  A firm charging high prices, making supernormal profits in the SR would attract a new firm to enter the market at a lower price.

  So, the threat of competion leads to the firm operating at a point where it only makes normal profit (AR=AC) and so would be more allocatively efficient than if there was no threat.
• Advantages of a contestable market theory

  1. Allocative efficiency​
  2. Productive efficiency​
  3. X-efficiency​
  4. Job creation
• A contestable market diagram:

  A) MC

  B) AC

  C) AR

  D) MR

  E) p (contestable)

  F) Q (monopoly)

  G) Q (contestable)

  H) P (monopoly)

  I) Quantity

  J) Costs / Revenue

  
• Disadvantages of contestable market theory

  1. Lack of dynamic efficiency​
  2. Cost cutting in dangerous areas?
  3. Creative destruction
  4. Anti-competitive strategies from the incumbents​
  5. In reality, a market is unlikely to have no sunk costs
  6. In reality, most markets have some consumer loyalty